Advisory Committee Suggests Additional Guidance for 403(b)s

The
Internal Revenue Service (IRS) Advisory Committee on Tax Exempt and Government
Entities (ACT) has issued a report of recommendations to the IRS.

In
the report section about 403(b) plans, the committee makes recommendations covering:

Universal
availability – The report says a review of the universal availability rules and
history provides a backdrop for a discussion of the key areas that need “soft”
guidance and/or expanded outreach programs.

“Orphan”
403(b) contracts – Unlike the majority of qualified plans, 403(b) participants
held individual contracts which, prior to the issuance of the 403(b) final regulations,
may have been placed with any number of vendors. If these participants severed
their employment prior to 2009 and no additional contributions were made to the
plan account after that time, based on guidance from the IRS, a plan sponsor
need not list these contracts in its plan. The report says the impact on the
rest of the 403(b) plan should these “orphan” plans fail to comply with the Internal
Revenue Code requires clarification.

Minimizing
contract leakage – The lack of ownership taken by certain 403(b) plan sponsors
seeking to avoid the “fiduciary” moniker has led to a challenge for vendors
when faced with a withdrawal request from a participant. Providing guidance to
vendors that would allow them to take certain actions would help to preserve retirement
assets.

403(b)
plan terminations – Given the many practical problems that are a by-product of the
nature of the 403(b) structure, additional guidance is needed to address the
more technical issues. However, there are opportunities for the IRS to supply
assistance through expansion of the online tools that are already available
that cover termination issues, the committee says.

Employee
Plan Compliance Resolution System (EPCRS) improvements – In light of the many
firsts experienced by the 403(b) community in the past decade, including the
upcoming restatement onto new pre-approved documents, there is a need to update
EPCRS to encourage use of the program and compliance with the Internal Revenue Code.
Possible improvements discussed include allowing certain loan failures to be
self-corrected, broadening the use of the Department of Labor (DOL) online
calculator, creating additional application schedules for 403(b) issues and
discounted fees.

NEXT: Universal availability issues.

The
ACT fielded surveys of 403(b) plan sponsors and providers, and more than half
of the respondents identified compliance with the universal availability rule
as the most significant operation issue that they face.

The
survey found there is much confusion about how the eligibility exceptions apply
to workers who do not exactly fit the permissible exception to the universal
availability rule. For example, employers often exclude from participation in
the plan student workers who continue to work over the summer (and thus, reach the
1,000 hours threshold). There is confusion about the application of the 20
hours per week and 1,000 hours rules and how to deal with temporary employees.

Universal
availability for non-Employee Retirement Income Security Act (ERISA) plans,
especially for employees whose hours are not tracked, but usually work less
than 20 hours per week (e.g., adjunct faculty); and

The
lack of detailed information with ample examples regarding excluded employees
and the 20 hours per week and 1,000 hours rules with an explanation about what
happens when employees exceed those hour limits.

The
ACT report recommends the IRS consider providing additional educational
outreach, in more detail, on at least the following issues in order to assuage
continuing plan sponsor uncertainty, confusion and ignorance about the
application of the universal availability rule and resultant noncompliance:

Treatment
of adjunct faculty at universities;

Treatment
of part-time, seasonal and temporary employees;

Providing
some type of relief from the tracking of hours burden for tax-exempt employers
(which frequently have very limited budgets and few staff);

The
meaning of the phraseology “reasonably anticipate” in terms of the 1,000 hours
threshold; and

How
the less than 20 hours per week standard is meant to apply. For example: Can employees who work less than
20 hours per week, who could be tested separately under Code Section 410 coverage
rules because they do not meet the minimum age and service requirements, be permitted
to make salary reduction contributions even in the absence of a specific
reference to Code Section 410 in the portion of the 403(b) final regulations
addressing the exclusion of employees who work less than 20 hours per week from
the universal availability rule?

NEXT: “Orphan” contracts.

In
response to the 403(b) plan survey, a number of respondents commented that
there continues to be considerable confusion and uncertainty as to what are a
403(b) plan sponsor’s obligations regarding “orphan” contracts. This concern
was also expressed by members of the 403(b) vendor community with whom the
committee had separate discussions about 403(b) plans.

The
vendor for a pre-2009 contract held by a former employee need not be listed in
the plan document (and the contract is not subject to the information sharing
requirements) if no contributions are made to the contract after 2008; and

Employee
contracts issued from 2005 to 2008 can be excluded from listing in the plan
document (and not be subject to the information-sharing obligations) if no
contributions are made after 2008 and reasonable, good faith efforts to
otherwise “include” such contracts as part of the plan (presumably for
operational purposes) are made.

According
to the ACT report, while the guidance did not address pre-2005 contracts to
which no contributions have been made since 2004, the general assumption has
been that such contracts are also not subject to plan document compliance (and the
information-sharing rules) where contributions have not been made to the contract
after 2004 (sometimes called “grandfathered” contracts).

The
committee recommends the IRS consider issuing guidance that clarifies:

The impact of operational violations under an
individual’s orphan contract on any other contracts that the individual may
have with the same employer; and

How pre-2009 frozen contracts issued to
current employees before 2005 should be handled for compliance purposes.

NEXT: Plan leakage and “lost” contracts.

Concerns
have been raised with the committee regarding the unnecessary leakage in
several respects under orphan and other contracts. First, given the lack of
guidance as to what can be done when there is no longer an employer (or where
the employer has no legal involvement), it has been observed that often the
only distribution option vendors are willing to make available to the contract
holder is a total distribution. In these circumstances, many vendors are
apparently unwilling to allow loans, partial withdrawals or transfers/rollovers
to another 403(b) contract to the extent employer approval is required.

Second,
respondents to the ACT’s survey, as well as members of the 403(b) vendor
community with whom it had separate discussions, expressed concerns that orphan
and other older annuity contracts are going unclaimed or otherwise getting
lost. What they are seeing is that contract issuers are often not making
sufficient efforts to keep in contact with the contract holders, resulting in
“lost” contracts.

The
committee was told this is happening because there is no clear-cut obligation
for issuers of old fixed annuity contracts to maintain current, or otherwise
find, information/records regarding the holders of these contracts.

The
report makes the following recommendations:

Greater
certainty is needed as to what the vendor can do under a contract in terms of
withdrawal and distribution where there is no employer involvement. Therefore,
the committee recommends that the IRS consider issuing guidance that clarifies
that the vendor can act as the decision-maker (in lieu of the employer) for
rollover and other withdrawal/distribution purposes under contracts where the
employer no longer exists (or is no longer legally involved).

The
committee says it is of the view that issuers should generally be required to
do more to ensure that orphan annuity contracts do not go unclaimed. Required minimum distribution (RMD) rules
could, in the committee’s view, provide a potential avenue for the IRS to encourage
this. While recognizing that the regulations generally provide that the
required RMD for one contract can be made from another contract held by the
individual, it nevertheless believes the IRS could issue guidance that requires
issuers to provide reasonable advance notice to contract holders on the RMD
requirements, and if the issuer does not have current contact information, make
reasonable efforts to locate the contract holder.

NEXT: Terminating plans with individual
custodial accounts.

Survey
respondents repeatedly mentioned there are problems terminating 403(b) plans
with custodial accounts. The IRS has taken the position that annuity contracts could be distributed to a participant without the participant’s consent; whereas a custodial account
not be distributed similarly. If a participant refuses to take a distribution,
or cannot be found to take a distribution, the custodial account remains in the
plan. The report says the absence of a practical solution for terminating
403(b) plans that includes custodial accounts is causing 403(b) plan sponsors
additional legal and operational costs and the need to follow questionable
solutions.

The
ACT says the IRS should explore with Chief Counsel whether it has legal authority
to create good faith or de minimis rules or provide other solutions to address
the practical problems of terminating a 403(b) plan. If the IRS does not have
legal authority to solve the practical problems, Treasury should seek
legislation addressing the problems or giving the IRS authority to address the
problems in guidance.

Regardless
of the results of that recommendation, the ACT says the IRS should expand its
web page with information about terminating a 403(b) plan. The current web page
explains how to terminate a 403(b) plan but does not recognize or address the
many practical problems sponsors and practitioners face when they actually try
to do a termination. The IRS’s revised web page should identify these issues
and suggest possible solutions.

In
addition, the report recommends the 403(b) Fix-It Guide should be expanded to address appropriate corrections for situations where
termination distributions have been made and rolled over, only to see the
termination fail because all assets cannot be distributed.

NEXT: EPCRS improvements.

The
IRS has made changes to its Employee Plans Compliance Resolution System (EPCRS) to allow 403(b) plans
to correct certain errors. But the ACT makes recommendations for further
improvements to the EPCRS.

The report recommends the IRS allow certain participant
loan errors to be self-corrected. Currently, the IRS’s self-correction program
(SCP) does not permit the self-correction of errors involving participant loan
transactions of any sort. Such errors can only be corrected through the
voluntary correction program (VCP) or Audit CAP (closing agreement program).

The committee notes there are several
complexities specific to participant loan error issues faced by 403(b) plans
that enhance the importance of devising a self-correction option. In a typical
403(b) plan scenario, the assets may be scattered among multiple vendors with
each participant having an individual account. It is also a frequent scenario
that plan sponsors discover a participant loan error with one vendor and then a
few months later find another participant loan error with another vendor. This
creates a perpetual cycle, and excessive costs, of having to file through VCP
for these types of corrections.

Another unique quality of the 403(b) plan
sponsor that drives the recommendation to allow participant loan failures to be
corrected through SCP is embedded in the structure of 403(b) arrangements. Many
403(b) plans are not subject to ERISA. These types of 403(b) plan sponsors are
very careful not to engage in activities that might result in it being subject
to ERISA and its fiduciary rules. One such activity that they fear would
trigger this is the policing of participant loans and, if they ultimately
become delinquent, the filing of a VCP application. So, the report says, while
there may be an important public policy goal of having loan failures corrected,
the plan sponsor, which is the entity that is in the best position to take the
steps toward that goal, has a competing interest that prevents it from doing
so.

Another
specific class of issues deals with problems that 403(b) plan sponsors
experience with vendors who are uncooperative or unresponsive to efforts to
correct errors reaching across multiple contracts or individual contracts that
do not recognize the role of the plan sponsor. Many of these contracts are
written as agreements between the service provider and the participant, which
the employer agrees to facilitate through its payroll system. There is no
provision for the administration of plan-wide matters by the employer. In other
cases, with many legacy contracts or arrangements, the terms do not facilitate
the fix that is prescribed by EPCRS for the “plan” and the employer doesn’t
have the ability to force the account holder (participant) to take the actions
necessary to bring the contract into plan-level compliance.

Among
other recommendations, the ACT recommends the IRS develop additional schedules
for the VCP filing to allow for correction of the most common 403(b)
operational failures. For example, the IRS
should develop a schedule specifically addressing a universal availability
failure with clear instructions about the correction options (similar to
Schedule 5 and the loan corrections).

The
report also recommends the IRS implement a document amnesty program for any
403(b) plan sponsor that adopts a pre-approved plan so that no correction of
prior documents is required and reduce the filing fees for the 403(b)
community, if only for a reasonable period of time, to allow compliance errors
in the remedial amendment period to be discovered and corrected.